USCB Financial Holdings, Inc.

Good morning, and thank you for joining us today for USDB Financial Holdings' second quarter 2023 earnings call. With me today reviewing our second quarter highlights is CFO Rob Anderson and Chief Credit Officer Ben Passos, who will provide an overview of the bank's performance, the highlights of which you can see on slide three. The past quarter saw the market react, process, and respond to the collapse of three high-profile regional banks. The news unsettled financial markets triggered a crisis in confidence amongst consumers and a deposit flight to the perceived safety of our too-big-to-fail brethren. At U.S. Century Bank, we build business relationships based on the best-in-class service, products, and people as our clients look to us for support and guidance. The USCB team responded immediately to the March events, contacting our clients directly to assail their concerns, answer their questions, and most importantly, educate them on their options for obtaining additional FDIC insurance coverage. To this point, the bank has reduced its uninsured deposit ratio by 10% over the past two quarters, as interested clients opt for available ICS and CDERS deposit products at U.S. Century Bank. Our efforts have been very well received. Deposit outflows were quickly curbed and the slowdown in loan demand experienced from mid-March through early May has dissipated. The loan closings in June were amongst the highest we've had in the past 18 months, and a growing quality loan pipeline is again strong, well-diversified, and reflecting consistent quarter-over-quarter increases in our weighted average coupon. We will review this progress in greater detail shortly. On a management level, our previous Board of Directors Chair, Dr. Ida Levitan, passed on the chairman's baton to me this past month for the full support of our board of directors. The board also confirmed Mr. Kirk Wyckoff, managing partner of Patriot Financial Partners, as lead director. I am grateful for the privilege of closely working with Dr. Levitan these past years, look forward to continuing collaborating with Mr. Wyckoff, and thank our board for their continued trust and support. On page three, in terms of growth, both loans and deposits have been growing at or above our stated guidance over the prior year. Liquidity improved over the past quarter, and as I stated, we assisted many clients into insurance deposit products. Net income was $4.2 million, or 21 cents per diluted share, and our ROAA was 0.77%, compared to 1.08% for the second quarter of 2022. Profitability was impacted by continued inverted yield curve and exacerbated by the bank failures of this past March. The banking sector's challenge of NIM compression continued in Q2 as deposits repriced faster than new loan yields. We believe that we are at or near an inflection point on our NIM as loan demand is back on track and pricing increases. In terms of capital and credit, both remain strong. During the quarter, the company repurchased 77,603 shares of USCB Financial Holdings Inc. at a weighted average price per share of $9.58. As of June 30, 2023, 172,397 shares remain authorized under the program. The following page is self-explanatory, directionally showing nine selected historical trends since recapitalization. Profitable performance based on sound and conservative risk management is what our team is focused on consistently delivering. So let's now turn our attention to our specific financial results and key performance indicators, which will be reviewed by our CFO, Rob Anderson.

Okay, thank you, Lou, and good morning, everyone. As Lou mentioned, U.S. Century Bank is dealing with a very challenging operating environment, and our second quarter results reflect this environment. While we review our second quarter results, I will be pointing out Why our management team feels more confident about the future. But first, let's cover the quarter. Total assets were $2.2 billion for the quarter. Loan balances were $1.6 billion. And deposits are at $1.9 billion. At quarter end, we had $439 million in securities. And like most banks in the industry today, these securities were put on the books during the pandemic period of very low interest rates. As interest rates have taken a fast and sharp rise, these securities now have a negative mark due to the mark-to-mark accounting treatment. Roughly 50% of these securities are treated as held to maturity, and the other half as available for sale. Total equity is now $184 million, flat to the prior quarter, although footnoted on the slide, the $184 million in equity includes $47.1 million in unrealized losses on the securities portfolio in AOCI. Moving on to the P&L, net interest income decreased from prior quarter and prior year as we deal with an inverted yield curve for an extended period of time. Non-interest income was relatively flat to the prior quarter, and as mentioned on our last call, the bank implemented CECL on January 1st of this year, and our provision expense was nominal for the quarter, as improved economic forecast drove a small reduction in expected loss rates, and this was partially offset by net portfolio loan growth during the quarter. Expenses were up from the prior quarter, and there are some moving pieces there, so I'll cover that slide in more detail in a few minutes. On a gap basis, net income was $4.2 million, or $0.21 a share, down from the prior quarter and prior year. Overall, I would characterize this quarter as reflective of a difficult operating environment. We are dealing with an inverted yield curve that has hung around for a long time, and it was just worsened by the recent bank failures in March. Moving on to our key performance indicators, in terms of soundness, our credit metrics remain strong. Our loan loss reserve coverage was down slightly to 1.18%. In terms of profitability, return on average assets was 0.77% and return on average equity was 9.13%. Our NIM was 2.73% and down 49 basis points from the prior quarter, driven by several factors, which I'll cover in more detail. Efficiency ratio was 65.25% and our tangible book value per share moved up slightly to $9.40, which is reflective of the negative mark of $2.41 per share on our securities portfolio and AOCI that I referenced earlier. Absent the AOCI mark, our tangible book value per share would have been $11.81. So let's cover deposits on the next page. A big part of our NIM story hinges on our deposits. First, in abundance of caution, given the recent bank failures, we brought in $50 million of brokered CDs at a weighted average rate of 4.98% to boost liquidity. Second, we finally experienced the mixed shift that most of our competitors experienced earlier in this rate cycle. On average, DDA balances dropped $62 million this quarter as clients sought out higher returns in money market and CD products. This movement had a more profound impact on our deposit costs, which moved up 70 basis points to 1.99%. Relative to the Fed funds rate increases, this puts the through-the-rate cycle deposit rate at 36%. Average DDA balances comprise 32.1% of total deposits at quarter end, which demonstrates the strength of our deposit book. If you take a closer look at our Deposit book on the next slide, our deposit base reflects our business model, a diversified commercial bank. 50% of our deposits are commercial accounts. 36% personal accounts, 11% public funds, which are partially collateralized, and 3% broker deposits. The total amount of uninsured deposits adjusted by the collateralized portion of public funds is 49%. Excluding the collateralized portion of public funds, the uninsured are 53%. I'd also point out that our ending spot balance of 1.921 billion is above our average balance for the quarter, demonstrating sustained growth at quarter end. So let's move on to liquidity. During the quarter, we strengthened our liquidity to 853 million, and this excludes our ability to tap the brokered or listing CD markets. As stated on our last call, the Federal Reserve created a new liquidity program to make additional funding available to depository institutions, We have enrolled in the bank term funding program but have not accessed the program and do not intend to access the program. Our on-balance sheet liquidity is $309 million, and our off-balance sheet sources, excluding brokered and listing CDs, is more than $544 million. We feel confident that these liquidity sources are adequate for us to navigate the current environment. So with that, let me turn it back to Lou to discuss our loan book.

Thank you, Rob. On page 10, on slide 10, we see the average loans excluding PPP loans increased 22.5 million or 5.8% annualized compared to a prior quarter and 290.1 million or 22.7% compared to the second quarter 2022. Directionally, portfolio loan yields have increased 109 basis points compared to the second quarter 2022, a trend that will continue through 2023. Let's see that in greater detail on slide 11. A slowdown in loan demand was noted from mid-March through early May 2023, immediately after the SVB triggered bank crisis. Market uncertainties made business clients and prospects understandably knee-jerk, but as the market has settled and fears of contagion have abated, production is back on track. As we see in the graphic on the left-hand side, Quarter to quarter, the weighted average coupon on new production continued to increase from 444 basis points in Q2 2022 to 720 basis points in Q2 2023, or 189 basis points above the portfolio average. In June 2023, gross closings topped 50 million, and the active pipeline has been reconstructed in a well-diversified composition That is, at a pre-SVB run rate, reflecting an estimated go-forward coupon of over 750 basis points for Q3. Portfolio diversification has been a focus of the management team, and over the past seven years, we have developed and added several non-CRE business verticals to our product lines, including association lending, SBA lending with a focus on variable 7 loans, yacht loans, and correspondent banking. As you can see on the loan composition graphic provided, 26% of the current portfolio is non-CRE as of Q2 2023, up from 9% at Q2 2020. The trend for greater loan diversification has picked up the pace in 2023 as the total new loan volume in Q1 and Q2 was respectively 66% and 81% non-CRE.

Okay, thank you, Lou. Moving on to our NIM page, net interest income decreased by $1.8 million compared to the prior quarter, predominantly due to an increase in deposit costs and a liability-sensitive balance sheet. We held more cash in the wake of recent bank failures and increased liquidity with higher price brokered CDs, both at a detriment to our net interest margin in the quarter. We also experienced the mixed shift with balances moving out of DDA and into interest-bearing deposits. As noted earlier, many of our competitors experienced this in prior quarters, so we finally caught up with the PAC. As Lou mentioned, the majority of our Q2 loan production was done at higher yields, were booked at the end of the quarter, so the full impact on the NIM has yet to be realized. All these events had a negative impact on our NIM, but we feel we are at or near an inflection point for the following reasons. First, liquidity and movement in our deposit book has settled down or abated. Second, we put on $50 million notional pay fix interest rate swap to take advantage of the inverted yield curve in the second quarter. Today, this swap has 172 basis point carry on the notional amount, which will improve our NIM by $860,000 on an annualized basis with no movement in rates. Next, we did a $100 million notional pay fixed rate swap in early Q3 and today has a 65 basis point carry or $650,000 on an annualized basis with no further movement in rates. Combined, these two swaps could potentially improve our NIM by $1.5 million on an annualized basis if rates stay steady. If the Fed continues to raise rates later this year, each 25 basis point rate hike will improve this number by another $375,000. And conversely, when rates drop, we could see the opposite. Fourth, our loan pipeline is strong and has a weighted average rate above $750,000. We believe net loan growth for the balance of the year will be in the low double digits, perhaps a tad higher. Fifth, we have nearly $100 million in cash sitting on the balance sheet that just repriced 25 basis points with the last rate increase. And we can deploy this cash into loans at $750 or above. The excess cash will also allow us to be opportunistic on deposit pricing should clients walk in the door with requests to match competitors' pricing. Let's move to the next page, which will highlight how our balance sheet is expected to behave given the latest rate movement. According to our ALM model, our balance sheet is neutral in year one and asset sensitive in year two. This is a direct result of having a higher portfolio of variable rate loans repricing in year two. As discussed before, our practice is to book 10-year fixed rate CRE loans that have a repricing mechanism after year five. We price these loans with an index tied to the five-year CMT. While we expect 33 of the variable and hybrid loans to reprice within a year, we have 227 million of loans repricing within the next six months. So with that, let me turn it to Ben to discuss asset quality.

Thank you, Rob, and good morning to all. Our A-triple-L is slightly lower in absolute numbers and in percentage of total loans. This is strictly due to improvement in the economic outlook. Non-performing loans continue to be minimal at $486,000. And our classified loans have decreased also in absolute numbers and as a percentage of total loans at $3,363,000 in classified credits. We should note that we do not have any CRE loans classified. Moving to slide 15, we have information on our loan portfolio mix. This portfolio has not changed appreciably from the numbers you have seen before. Out of a book of 1.595 billion, CRE loans amount to 989 million, inclusive of owner-occupied loans. Our CRE concentration has decreased and is now lower than at fiscal year end of 2022. Our biggest concentration is in the retail segment with 297 million, which translates into 30% of the CRE portfolio. The table in page 15 gives you metrics of the CRE book. Weighted average long-term values ranging from 54% to 62%. debt service coverage ranging from 141 times to 220 times, and average loans conservatively low ranging from 1.2 million to 4.8 million. Moving to slide 16, we have information on our CRE office segment. Again, not much change from what you have seen before. The metrics show how clean this portfolio is. 91% of outstanding loan balances are within the bank's primary market. Finally, I should note that Miami's office sector outperforms the national averages with lower vacancy of 9.4% and availability rate of 12%. Going into slide 17, Rob will talk about our non-interest income.

Thank you, Ben. We had a steady quarter for non-interest income. Service fees were flat to the prior quarter but up from the prior year. SBA fees were slightly down from the prior quarter as we saw fewer loan sales this quarter. With these straightforward, let's take a closer look at expenses. Our total expense base was $10.5 million and slightly up from the prior quarter. Salaries and benefits were down as we decreased the incentive accrual based on company performance through Q2. Like others, our FDIC assessment was up this quarter and largely attributed to the increase. Other operating expense, which increased $468,000 due to audit and tax services, internet banking fees, and special assets insurance expense. While some of these expenses are due to timing of when the invoices are paid, we are seeing a general increase in other operating expense, which we project at the current or near current pace for the remainder of the year. In terms of a forward run rate, we feel our quarterly expense should be at or slightly lower than our 10.5 million. So with that, let me take a quick look at capital. Capital levels remain above well-capitalized levels, and we were able to pick up 77,603 shares at a weighted average price of $9.58 in the quarter. We have 172,397 shares remaining under our current authorization, which will allow us to be opportunistic if the share price retreats. So with capital straightforward, I'll turn it back to Lou for some closing comments.

Thank you, Rob. As we navigate this challenging operating environment, our management team is mindful of the current economic conditions, taking prudent approach in managing our balance sheet, liquidity, expenses, and capital. While we conservatively manage asset quality and risk, our focus is on enhancing our margin and profitability while limiting growth in certain asset classes. In terms of closing comments, I'll say the following. Delivering a 77 basis point ROA is not sitting well with this management team. While a quarter does not define our performance, we ask you to review our longer-term trend performance on page four, which demonstrates consistency in delivering sound, profitable growth since 2016. We have laid out several goals which we feel are reasonable and achievable for the team to deliver in the near term. They include an ROAA of 1% or better, an ROAE of 10% or better, NIM to steadily rise to 3% by year end and improve further into 2024, loan and deposit growth above 10%, quarterly expenses below $10.5 million, and to continue our operations in a safe and sound manner to ensure our credit book remains clean. Our primary near-term focus is to improve our NIM, Rob discussed many specific actions that we have already taken to do so, and we have other viable opportunities to explore as we get into the second half of the year. With that said, let's open the floor to Q&A.

This floor is now open for questions. To ask a question at this time, please press star 1 on your telephone keypad. If at any point you would like to withdraw from the queue, Please press star one again. Our first question comes from the line of Brady Gailey with KBW. Your line is now up.

Thank you. Good morning, guys. Morning. Morning. So the buyback was you were active in the buyback in the second quarter, but it did slow from 1Q levels. I mean, the stock is still relatively cheap on tangible book values. How do you think about utilizing the rest of your authorization and the buyback?

Yeah, I would say in the second quarter, price slowed because we were a little hesitant with the bank failures and making sure no other activity would really fall during that quarter. I think we feel a little bit better We really are using the buyback to support our stock. We feel it's a great opportunity to buy if it ever goes back down to tangible book value. And we bought it at 958. Our tangible book value is 940. It's up appreciably since then, and we think that was a smart move. So again, we view the buyback as more opportunistic. Our capital is here to deploy and make loans and take take bigger risks than just buying it back. But sometimes our capital is best used on the buyback. In this quarter, we got it at $9.58. All right.

And then the two swaps that were added of $150 million, I think you said the NIM impact would be a benefit of $1.5 million annually. What is the life of those swaps?

Yeah, so we have them... Kind of layered in, they're probably in between two and three years is the terms on those, Brady.

Okay. And finally for me, U.S. Sentry does screen a little high when it comes to office. So I just wanted a little more of an update on how you think office is performing in in your markets and do you anticipate, I mean credit quality is so clean for you guys right now, but I was just wondering if you anticipate seeing any noise in office over time?

Well, we are really watching every segment in our CRE book. Office, we know there is a big concern nationwide In Miami, Office is probably the best market in the US. And this is not my opinion. This comes from third party studies that we have commissioned and paid for. We do not have a big office concentration compared to other segments. And we are carefully addressing every fundamental either in new requests or annual reviews. I cannot say that I anticipate any major issues in office, frankly, but I understand your concern.

Okay, great. Thanks for the color, guys. Thank you, Brady.

Our next question comes from Michael Rose from Raymond James. Your line is now open.

Hey, good morning, everyone. Thanks for taking my questions. Good morning. Rob, good morning. I wanted to start just on the margin, appreciate kind of all the color and kind of the puts and takes. Can you just remind us what your beta assumptions are and where you think NIV-MIX and then just on the DDA side, I know you have several different lending verticals. Are any of those a source of deposits that you guys can maybe push a little bit harder on? Thanks.

Okay, yeah. So probably a year ago when rates started to increase, we said no quarter should make the rate cycle. So we always said kind of through the rate cycle, we could be up to around 35% on a total deposit beta. So we're at that peak right now. We're anticipating betas on our money markets around 40%, and then CDs repricing around 75%. So we're hoping to hold the line. We do have $100 million in cash. I can tell you we had clients come in the door the past few days and asking for rates at 540%. We had a lot of competitors post-March run specials. Some of those have abated, but others have not. First Horizon was big in the marketplace with a 538 money market account. We were only matching on select basis, but I'd like to see our core DDAs come back a bit and hold it at 36%, but that's certainly a challenge for us.

Okay. Um, appreciate that, uh, that color. It's obviously, uh, very challenging. Um, and then just on the, on the loan growth front, um, you know, you guys, uh, continue to have, uh, you know, some momentum, but you know, a little bit slower than in prior quarters, just wanted to get a sense for kind of the competitive dynamics in the market, um, what we could expect, you know, for growth over the next couple of quarters. And, um, I don't know if you mentioned this, Rob. I'm sorry if I missed it, but kind of the new production loan yields are where loans are repricing to. Thanks.

Sure. Good morning, Mike. This is Lou. We are, as I mentioned, we have been doing very, very well the last, actually the last year in a shift on seeing more C&I lending than we've ever had historically here. doing very good business on the HOA side, on the SBA side. The yacht loans, which are consumer, are coming in very steadily and very strongly, and we're being very selective on all our CRE. Again, as Ben pointed down, they've actually trended down. The CNI component gives us more opportunity on deposits. Again, the HOA and our jurist advantage initiatives, which is focused on the attorney market, have consistently delivered, and we don't think that that's going to stop. Our foreign correspondent banking has also been doing very, very well on bringing in additional core deposits, so we believe that that's going to continue very steadily. We believe that our production is going to be on a low single digit going forward. It's going to be more in line with what we saw last year, which I believe we were doing quarterly fundings of about $125 million per quarter. That's what I anticipate for the next two quarters. Again, we're looking at our go forward pipeline and projecting that we're going to be seeing a coupon well over seven and a half.

Got it. And Lou, just to appreciate slide 11, you know, with CNI at 26%, is there a target level you'd like to strive to get to in terms of a mix percentage?

I would probably like to shoot for that to be at about 35 to 40% of the overall book. I think a lot of community banks are really desirous of that. Having been in this market for 41 years, I can tell you it's not easy. And we've had the greatest success here because we've developed real verticals with real subject matter experts that we brought in from larger banks. They've been able to not only assist in developing the strategies, writing the policies, training the team in order to leverage the overall production team. So I do believe that these are all going to continue, and you're going to be seeing our CNI component, our non-CRE component, portion increase and again a move from 9% in 2020 to 26% in the second quarter I think it's been pretty significant we're very pleased with that and we believe that that's going to continue but not notwithstanding you know we're in South Florida and this is a real estate denominated economy We do CRE lending well. We're not shy about doing it, but we're not transactional, and we're always trying to bring in the best quality business fully banked.

Great. Thanks, Lou. Maybe just finally for me, just on the expense side, appreciate the color around relatively stable expenses from here. Sorry if I missed this, but you guys did have a step down in the salaries line, and the employee count has continued to you know, March a little bit higher. I think you were at 178 or so. Um, I think that was up to sequentially, but, um, just wanted to get some color there. And then, you know, are there any, uh, you know, other levers that you can pull on the expense side to, to bring that cost a little bit? Thanks.

Yeah. So on the expenses, um, you know, salaries and benefits decreased, we did lower our incentive accrual and that's based on company performance. So, you know, our, our, I guess our mantra here is that, um, If the team wins, we all win, and if the team doesn't do our stated goals, then we bring that down. So, you know, we'll adjust that on a quarterly type basis, but there are some opportunities, and we'll be looking at everything that's on the table, I'll tell you that. But I would say right now we expect the 10.5 at or slightly below as a run rate. Great.

Thanks for all the color, guys. Appreciate it. Thank you, Mike. You're welcome.

Thank you. All right. Our next question comes from Betty Strickland from Jenny Montgomery Scott.

Hey, good morning, gentlemen.

Morning. Morning, Freddie.

If I heard you correctly, I think you mentioned the margin should get back to around 3% by the fourth quarter. Just thinking through how we get there, is that the result of deposit cost stabilizing since you had more kind of a front-loaded beta, earning assets rising from, you know, remix, new production, you have the swap. Is it the combination of those, you know, factors primarily, or are there some other levers you're able to pull in there too that are driving that outlook?

Yeah, so on the margin, you know, certainly, you know, a 270 margin is not going to cut it for us. So we've got to put out a number of things that will get us back to the 3%. We feel like we can grind higher. I think 3% is a good goal for us. The main item that I would say, and there's multiple factors that would contribute to that, but the main one is putting on higher earning asset yields above 750. So Lou mentioned the 125 goal as loan production as a quarter at 750 or above. We have to hit those marks for us to hit our margin goals. Certainly controlling our deposit costs. The swaps, you know, will help a little bit on the margin on the edges. But the main thing is controlling our deposit costs and putting on higher yields. And if we get some loans repricing, that's going to be great. We do have some of that opportunity. but the main piece is putting on higher earning asset yields.

Understood. That makes sense. And kind of along that same line of questioning, what was the term of that brokered CDE brought on? And could we see more of that, or was that really just a one-time move to shore up liquidity, not necessarily as much to, you know, a way to grow deposits necessarily?

Yeah, so the brokered CDE was around a two-year where we're – We're rolling those, and I think that is probably more of a one-off than anything else right now. I mean, we're getting at or near the end of the rate cycle, but we're still living in an inverted yield curve. We anticipate that to go on for some time, whether the Fed pauses or not. I mean, we're still inverted. So going out on the curve two to three years is the reason for the swaps.

Got it. And just one last one for me. I saw the liquidity coverage of uninsured deposits grew, I think, to around 90% this quarter. Is that something you're focused on, whether you want to get that to 100% or whether you're happy where it is, or is it just not as much of a concern given that in the past it seems like your depositors haven't been too worried about it?

Well, I think the uninsured deposit figure is very reflective of our business model. We're simply not a retail bank. We have correspondent banks here that don't discuss that. We've talked to all our clients. When the March events happened, probably within 48 hours, we spoke to all our top clients broken down by the different portfolio managers. Each one spoke to their top 25. Everybody was concerned and kind of unsure of what was happening. What we did very quickly is that we white-labeled the ICS and the Cedars products that we traditionally have had, which in the past the only ones that really were interested were the HOAs. So as we educated the clients, more and more wanted to, I guess, be on the safer side. And so you started seeing that shift mix, as Rob refers to it. I think that slowly that will continue to gain popularity. I don't think it's going to make a big move at this point in time. But one of the things we are doing on an ongoing basis is to continually educate the customer should there ever be any kind of significant event people just know that they don't have to go anywhere. They can do it here. And so I think we've done a good job in educating them and creating the product and, you know, steady as she goes.

Makes sense. Thanks for that. Appreciate the color, guys, and congrats, Lou, on the chairman role.

Thank you very much. Thanks, Freddie.

At this time, there are no more questions.

Okay, thank you all for attending this earnings call and for the dialogue we've had. We always welcome the opportunity to take your calls, field any questions, and share our plans. While the industry is traversing a very challenging operating environment, we look for opportunities to improve and capitalize on these challenges. I have full confidence on this team and board. They are the very ones that worked so hard in turning this franchise around, taking it in under six years from a regulatory oversight to a successful IPO. Our plan is clear. The Florida economy is among the best in the nation. The team is motivated and delivering results. And as I said earlier, a single quarter does not define our performance. So we look forward in delivering this plan and in updating you all on our progress on our next earnings call. With that said, thank you all very much and have a great weekend.

This concludes the meeting. You may now disconnect.